A speculator is an individual or financial institution that places short-term bets on the securities based on speculations. Rather than focusing on the long-term growth prospects of a particular company, they would take calculated risks on a stock with the potential of yielding a higher return.
With a deep understanding of financial markets, speculators often take the form of venture capitalists or hedge funds. They factor into market research and technical analysis to understand the movement of an asset price in one direction or the other.
- Speculators are individuals (or institutions) that practice short-term bets on assets with the expectation of generating a profit.
- Instead of looking for a company’s long-term prospects, they are more concerned with the stock’s ability to experience a significant price rise in a short period.
- Different types of speculative traders, including market makers and private equity firms, utilize different trading strategies to buy securities and benefit from price changes.
- They play an essential role by adding liquidity to the financial markets, making it easier to buy and sell when needed. However, uncontrolled speculator activity can lead to a speculative bubble or market crash.
How Do Speculators Work?
The main reason behind people putting their money into securities is to make long-term or short-term profits. As such, financial markets feature investors and traders with the same goals – to make a profit and avoid losing money. While some individuals focus more on the “make a profit” aspect, others adopt the “avoid losing money” approach. It is also a well-known fact in the trading community that long-term investments tend to be less risky than those made for the short-term.
When it comes to speculators, they tend to fall on the “make a profit” end. It happens because the speculation style of trading generally involves taking on more risk than other types of individuals in the financial markets, such as investors. The additional risk comes from trading assets that are considered volatile, or in other words, stocks that are prone to making dramatic price changes. However, one can also speculate on non-volatile assets that have not been discovered yet by other investors.
They can maximize their returns by using leverage or using borrowed money to expand their position. But using leverage strategy while speculating can lead to significant losses. For example, Bill Hwang, who managed the private investment firm Archegos Capital Management, lost $10 billion by speculating on the stocks of ViacomCBS (VIAC) and building his position with various risky financial instruments.
To be a speculator requires a lot of research and expertise, or what is referred to as doing due diligence. It is vital to know the risks involved with the asset, as well as the potential reward. Another essential aspect of speculation is the timing of the trade. The timing is crucial because, as a speculative trader, one expects a dramatic change in price in a short amount of time.
People will often associate them with gamblers. However, the difference between the two groups of individuals is that a speculator will take “calculated risks” to make sure they are best positioned to make a profit. In contrast, a gambler is just hoping for a return.
Types of Speculators
There are several different groups that a financial market speculator can be categorized into, including:
#1 – Bulls
Individuals classified as bulls mean they are expecting the asset price to increase in value. They will purchase an asset with the expectation of selling it back for a higher price later. Bulls remain optimistic about the asset’s price, believing it will be worth more when they sell it, and if it is, they make a profit.
#2 – Bears
Bears are the opposite of bulls when it comes to speculation in the financial markets. They expect the asset price to decrease in value and bet on their decline. Bears will profit when short selling an asset, such as stock, and repurchasing it at a lower price later.
Fun Fact: Bulls and bears in the financial markets get their name from how they strike. Bulls strike up (bullish), and bears strike down (bearish).
#3 – Lame Duck
A lame duck speculator is someone who finds themselves in a situation that is not what they expected. These traders suffer unexpected losses due to a lack of devising an effective trading strategy. Typically, the term is used to describe a bear incapable of meeting its end of the deal but can also apply to bulls.
#4 – Stag
Stags are a different type of speculators in which they expect to profit on very short-term price changes in new company stocks. Stags will often be more careful than others on this list regarding risk and profit. They speculate on capturing profits as the asset demand increases, driving its value up.
How Speculators Affect the Market?
They play a vital role in the financial markets, even though some people view the method as reckless or manipulative.
One of the most critical factors for any financial market is the availability of liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses., or the ability to buy and sell with ease. They can add liquidity into markets that are not as popular among investors, such as commoditiesCommoditiesA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units. or the foreign exchange (Forex) market. For example, speculative traders increased their net short positioningShort PositioningA short position is a practice where the investors sell stocks that they don't own at the time of selling; the investors do so by borrowing the shares from some other investors to promise that the former will return the stocks to the latter on a later date. on the US dollar in the week of February 26, 2021, according to data released by the Reuters and Commodity Futures Trading Commission.
When a well-known market speculator such as Jesse Livermore or Michael Burry enters a speculative position, others will often follow, increasing demand and driving the value up.
Help Control Price Volatility
When a stock has a dramatic price change in either direction, a speculative trader will sometimes enter a position with the expectation of the price reversing. This behavior can help control assets with high volatility and influence the price to find a median. However, it can also work the opposite way, where speculative traders will pile into security, causing the asset to become more volatile.
Speculator vs Investor
They often get classified as investors, but these two groups of individuals have several differences.
A Speculator –
- Often takes on additional risks
- Speculates for short term price changes to make a profit
- Strives for high returns in a short period
- Is not necessarily concerned with the long term growth potential of an asset
- Is in the financial markets to trade assets
An Investor –
- Can take on risks, but typically less than a speculative trader
- Holds assets for a more extended period, getting a better possibility of generating a return
- Looks for growth over the long term to create a profit
- Hopes for incremental returns over some time
- Is very concerned with the long term growth potential of a company
- Is in the financial markets to invest in companies
Also, you may want to look at Investment vs SpeculationInvestment Vs SpeculationInvestment is when a security or an asset is purchased to hold for a long-term period anticipating that it will gradually increase in value over time. In contrast, speculation is a more risk-based transaction where the sole purpose is to make a single short-term profit.
This has been a guide to What is Speculators & its Definition. Here we discuss the types of speculator and how it works along with how do speculators affect the market. You may also have a look at the following articles to learn more –